Karoon has little to croon about

Former market darling
Karoon Gas Australia
is finding out the hard way just how volatile the oil and gas exploration game can be. After its stock soared near $11 as recently as October, a set of regulatory hurdles and market mishaps have sent the energy explorer thudding back to ground and its shares are trading at almost half the value of last year’s glory days.

The company, led by executive chairman Bob Hosking, hit impressive highs in April 2009, after potentially unearthing vast quantities of gas from its much-vaunted Poseidon exploration well in West Australia’s Browse Basin.

The explorer’s shares went on a golden run as Karoon and the operator of the gas field, US oil giant ConocoPhillips, spruiked piping Poseidon’s gas across to Conoco’s Darwin liquefied natural gas plant.

Karoon also owns acreage in Peru and one of the hottest addresses in worldwide oil exploration: Brazil’s Santos Basin, which shot to fame in 2007 with the discovery by state-run oil giant Petrobras of the Tupi oil field estimated to hold 8 billion barrels. Despite the prized real estate, the problem for Karoon was its belief that the value of its early-stage assets in Brazil and Peru were not being reflected in the Australian market, where investors were mostly focused on its Browse exploration play with Conoco.

Its solution last October was ambitious but risky: a $2 billion spin-off and float of its South American oil and gas assets on Brazil’s Bovespa stock exchange.

The initial public offering was scrapped last November due to poor market conditions, raising question marks over the credibility of the executive team and the company’s ability to fund its upcoming Brazilian drilling campaign. While Hosking left the door open to revive the float, a change of strategy was required, and the withdrawal of the float sent its shares back to just $7.

Karoon opted for a series of new joint venture deals on the continent and an aggressive nine-well drilling program as the cure for its ills. While that is a promising long-term prospect, local investors ascribe little value to the international forays. They consider Poseidon the prize and are impatient for more details of the economics of the well.

Yet even the development of that asset has become a troublesome exercise as environmental and petroleum regulators step up their scrutiny of offshore drilling plans after BP’s Gulf of Mexico disaster in the US and the 2009 Montara oil spill in the Timor Sea, one of Australia’s worst oil disasters. Karoon’s Browse drilling program was due to start in March but was delayed after the federal Environment Department insisted on a tougher review of the $500 million to $700 million campaign in the wake of the accidents.

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At first glance, the review appeared a minor administrative hurdle, and a decision was due yesterday on whether the two companies could proceed. But it has now emerged the government has “stopped the clock" on the project to seek further information before deciding whether it requires a full environmental assessment.

Karoon and Conoco are thought to have modified their drilling program, possibly by omitting the well closest to the environmentally sensitive Seringapatam Reef. But the rig hired for drilling on the permit has expired, meaning the companies could face difficulty in securing a suitable rig. The worry for Karoon is that their project has the potential to become a ‘test case’ for the government’s new laser-like focus on offshore safety, potentially delaying drilling at Browse into the new year.

Karoon has raised more than $550 million from investors since 2005, so its ability to fund an ambitious pipeline of projects is not being called into question and it has about $280 million still sitting in its coffers. But until drilling starts at Browse or a partial sell-down of its Brazilian projects takes place, investors may be wary of throwing more cash at the explorer until it can unload some of its capital spending commitments.

The company that was touted as Australia’s next Woodside Petroleum just two years ago has been dealt a harsh lesson in the high-risk, high-reward stakes of offshore oil exploration.